Econometrica: Sep, 2005, Volume 73, Issue 5

Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation

https://doi.org/10.1111/j.1468-0262.2005.00630.x
p. 1587-1621

Narayana R. Kocherlakota

In this paper, I consider a dynamic economy in which a government needs to finance a stochastic process of purchases. The agents in the economy are privately informed about their skills, which evolve stochastically over time; I impose no restriction on the stochastic evolution of skills. I construct a tax system that implements a symmetric constrained Pareto optimal allocation. The tax system is constrained to be linear in an agent's wealth, but can be arbitrarily nonlinear in his current and past labor incomes. I find that wealth taxes in a given period depend on the individual's labor income in that period and previous ones. However, in any period, the expectation of an agent's wealth tax rate in the following period is zero. As well, the government never collects any net revenue from wealth taxes.